After a week in which president Donald Trump warned that the US could “totally destroy” North Korea in defending itself or allies, the administration on Thursday (Sept. 21) issued an executive order imposing a series of new sanctions on businesses that deal with the nuclear weapon-armed country. North Korea, for its part, threatened “highest-level” action, which the country’s foreign minister unreassuringly clarified could include detonating a hydrogen bomb in the Pacific.
North Korea has continued with the development of its weapons programs despite the imposition of increasingly severe primary sanctions, directed at people and entities of the targeted country. That’s why politicians on both sides of the aisle and commentators of all stripes have been clamoring for the US to impose what are known as “secondary sanctions.” Secondary sanctions target non-US companies that engage in otherwise lawful transactions outside the US with parties from the sanctioned nation. So, for example, if a Malaysian bank does business with North Korean nationals and companies in Malaysia, then no US bank can do business with that Malaysian bank, even if the transaction between the US and Malaysian banks has no nexus whatsoever to North Korea. And of equal importance, that Malaysian bank can no longer do any business in the US.
This week’s executive order takes the US one step closer to the imposition of secondary sanctions. Section 4 of the order gives the Treasury Department the discretion to impose sanctions on foreign banks in the US if any of their foreign operations “knowingly” conduct or facilitate any “significant transactions” on behalf of any blocked North Korean parties or “in connection with trade with North Korea.” President Trump summed up the concept (paywall) of secondary sanctions when he reportedly said during a lunch with the leaders of Japan and South Korea, “Foreign banks will face a clear choice: Doing business with the United States or facilitate trade with the lawless regime in North Korea.”
Secondary sanctions sound appealing, especially when all actions taken by the US and its allies have so far failed to dissuade North Korean leader Kim Jong-un from lobbing ballistic missiles over Japan in his Dr. Evil-like drive to hold the world to ransom with an increasingly sophisticated nuclear program. Secondary sanctions appear to make for a hardline, yet non-military option, but they present a number of significant downsides.
While North Korea often is viewed as a hermit state with few ties to the international community, it in fact enjoys diplomatic and trade relations with a sizeable number of countries, most notably China, its chief trade partner, and Russia, as well as Brazil, Germany, and Malaysia. The focus of the US secondary sanctions movement, however, has been almost entirely on China, and more specifically, the big Chinese banks that rank among the largest financial institutions in the world.
For example, Ed Royce, chairman of the House Foreign Affairs Committee, has argued (paywall) that the US should target “major Chinese banks doing business with North Korea.” The US Senate Banking Committee held a hearing over the summer titled “Secondary Sanctions Against Chinese Institutions: Assessing Their Utility for Constraining North Korea,” where much of the testimony and questioning centered on Chinese banks. Former CIA deputy director and Treasury official David S. Cohen, who served in the Obama administration, recently argued in favor of implementing secondary sanctions that target Chinese banks.
In this age of sound-bite-driven news cycles, no one wants to risk seeming soft on North Korea, but secondary sanctions are not the magic bullet advocates suggest. In fact, secondary sanctions can be deeply problematic and counterproductive. They are unlikely to prove effective, and they would destabilize Sino-American diplomatic and economic relations precisely at a time when we need China’s sustained help on North Korea. The imposition of secondary sanctions will also result in “de-risking” by US banks.
Reacting to pressure from various government regulators and private litigants, banks are rejecting whole swaths of customers based in risky regions and industries, a trend called “de-risking.” De-risking creates real difficulties for businesses and ordinary people for whom getting a bank account is becoming a harder endeavor, while forcing them to turn to informal (and less transparent) channels to move their money. Secondary sanctions can make the problem worse.
For example, whole communities on both sides of the US-Mexico border have been cut off from the banking system because banks want to avoid any unintended connection to illegal drugs or human trafficking. Somalis living and working in the US can no longer remit money home to their families because all U.S. banks have severed any correspondent banking relations with any Somali banks. HSBC, among other banks, has refused to do business in Myanmar, Angola and Iraq. A recent survey published by the Association of Certified Anti-Money Laundering Specialists, whose members include international financial institutions and law enforcement agencies, found that 40 percent of respondents have exited entire markets due to regulatory risks and increased costs, and a further 33 percent plan to exit markets within the next year.
Despite the hardships caused by de-risking, this response by the banks is understandable. Banks have concluded that they will be punished any time money reaches criminals, regardless of their own due diligence efforts. They calculate that it is better to drop all potentially risky customers than expose themselves to litigation or regulatory action. Imagine the de-risking that would take place if US and foreign banks believe that any Chinese bank or company may possibly have ties to North Korea. China is no Somalia or Iraq or Angola. The economic dislocation and turmoil created by the mass de-risking that would follow would be profound.
Proponents of secondary sanctions argue that they worked in forcing Iran to the nuclear negotiating table. But Iran was different. When the US decided to employ secondary sanctions against financial institutions doing business with Iran, the country had already faced years of isolation as the target of a unified drive by the US and its allies to sanction Iran’s mullahs into submission. As nonproliferation expert Aaron Arnold recently wrote in The Diplomat, “Iran was already largely cut off from the global financial system—especially among the United States’ chief economic partners.” That is not the case with North Korea, and it is certainly not the case with China.
Meanwhile, China has a vested interest in making sure that North Korea, which sits on China’s northeast border, does not become a failed state. Former Treasury official Adam Szubin put it this way (pdf) to the US Senate Banking Committee: “China will not ‘roll the dice’ when it comes to the fate of its impoverished, nuclear-armed neighbor, and concerns over stability will be paramount.”
Even those who advocate secondary sanctions recognize the diplomatic sensitivities associated with imposing these typically blunt instruments on China and its banks, where such secondary sanctions would be seen as a challenge to sovereignty. We cannot castigate China one moment and then expect a cooperative response from the Chinese leadership at the next turn, particularly when secondary sanctions on large Chinese banks could cause major disruptions to the Chinese economy.
While imposing secondary sanctions on Chinese banks may seem like an attractive option—particularly to politicians seeking immediate results to publicize during the next election—the US and its allies would be better served seeking a comprehensive solution to the North Korea problem. President Trump needs to work with Congress to formulate a serious plan that at least begins to address China’s concerns over border stability—that would make it much more likely that the US can convince those within the Chinese leadership with influence over North Korean policy to adopt measures that will finally bring Kim Jong-un to heel. Bombast may win US elections, but a protracted geopolitical power struggle requires subtle and coordinated diplomacy.